Endogenous risk is a type of Financial risk that is created by the interaction of market participants. It was proposed by

Jon Danielsson Jon Danielsson is an economist teaching at the London School of Economics and active in domestic and international policy debates. He received his PhD in the economics of financial markets from Duke University in 1991. Career Danielsson's resear ...

and

Hyun-Song Shin Hyun Song Shin () is a South Korean economic theorist and financial economist who focuses on global games. He has been the Economic Adviser and Head of Research of the Bank for International Settlements (BIS) since May 1, 2014. Previously, he w ...

in 2002. Risk can be classified into the two categories of exogenous and endogenous risk. Under exogenous risk, shocks to the financial system arrived from outside the system, like an asteroid might hit the earth. Market participants react to the shock but do not influence it. By contrast, with endogenous risk, the interaction of market participants, each with their own abilities, biases, prejudices and resources, results in most market outcomes and all large outcomes. In particular,

systemic risk In finance, systemic risk is the risk of collapse of an entire financial system or entire market, as opposed to the risk associated with any one individual entity, group or component of a system, that can be contained therein without harming the ...

is a form of endogenous risk. As a practical interpretation of endogenous risk when applied to risk measurements, it can be further subdivided into actual risk, the underlying latent risk and perceived risk, what is reported by common risk measurement techniques, such as

Value at risk Value at risk (VaR) is a measure of the risk of loss for investments. It estimates how much a set of investments might lose (with a given probability), given normal market conditions, in a set time period such as a day. VaR is typically used by ...

and

Expected shortfall Expected shortfall (ES) is a risk measure—a concept used in the field of financial risk measurement to evaluate the market risk or credit risk of a portfolio. The "expected shortfall at q% level" is the expected return on the portfolio in the wor ...

. Shown in the figure on the right, as a financial asset enters into a bubble state, followed by a crash — up by the escalator, down by the lift — perceived risk, what is reported by typical risk measures, falls as the bubble builds up, sharply increasing after the bubble deflates. By contrast, actual risk increases along with the bubble, falling at the same time the bubble bursts. Perceived risk and actual risk are negatively correlated.

References

Financial risk {{finance-stub

See also

References